What is the Hindenburg Omen?

The Hindenburg Omen is the alignment of several factors that measure the underlying conditions of the stock market, in particular the New York Stock Exchange (NYSE). The main goal of the indicator is to determine if a higher overall probability exists such that a stock market crash has a higher likelihood than normal.

It is created by monitoring the number of securities that form new 52-week highs relative to the number of securities that form new 52-week lows - the number of securities must be abnormally large. This criterion is deemed to be met when both numbers are greater than 2.2% of the total number of issues that trade on the NYSE for that specific day.

The Hindenburg Omen can also assess to a limited extent if a probability of a severe decline is on average higher than normal.

The Hindenburg Omen is said to have originated with the blind mathematician Jim Miekka who was probably the foremost expert on the Omen suggested that the pattern be dubbed the "Hindenburg Omen" after that ill-fated dirigible.

The data used to calculate the Hindenburg Omen was officially tripped on August 12, 2010. There were 92 companies that hit new 52-week highs on Thursday, or 2.9% of all companies traded on the New York Stock Exchange. There were also 81 new lows, or 2.6% of the total. Each number must exceed 2.2%. Other criteria include a rising 10-week moving average for NYSE and a negative McClellan Oscillator, a technical indicator that measures market fluctuations.

Some analysts have predicted that there is a 77% chance of a drop of 5% or more.

The Omen occurred seven times in 2008 as the S&P 500 posted its biggest annual drop since the Great Depression.

Criteria

The traditional definition of a Hindenburg Omen requires that:

1. That the daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 2.2 percent of total NYSE issues traded that day.

2. That the smaller of these numbers is greater than or equal to 69 (68.772 is 2.2% of 3126). This is not a rule but more like a checksum. This condition is a function of the 2.2% of the total issues.

3. That the NYSE 10 Week moving average is rising.

4. That the McClellan Oscillator is negative on that same day.

5. That new 52 Week Highs cannot be more than twice the new 52 Week Lows (however it is fine for new 52 Week Lows to be more than double new 52 Week Highs). This condition is absolutely mandatory.

These measures are calculated each evening using Wall Street Journal figures for consistency. The occurrence of all five criteria on one day is often referred to as an unconfirmed Hindenburg Omen.

A confirmed Hindenburg Omen occurs if a second, or more, Hindenburg Omen signals occur during a 36-day period from the first signal.

Weaknesses with the Omen

To eliminate the potential for false positives some technical analysts have imposed the condition that the Hindenburg Omen must have occurred 3 times in a row within a month from the 1st event for the initial trigger signal to be considered to be valid; must be valid when all tightly coupled triggering events are within a 14 working days will indicate a possible future downturn or correction, depending on the magnitude of any single Hindenburg Omen event.

Singular Hindenburg Omen signals are always considered unconfirmed as the indicator has a high false alarm rate.

The 2.2% number seems to be tied to (or gives the appearance of being) the average growth within the US economy since 1955, an average of only about 2%. The original creators of this signal have not fully explained their use of 2.2% constant, but apparently chose it because that was the number that their testing of historical market data showed was statistically meaningful.

The effects of the recent merger of the NYSE with Euronext may have an effect on future predictions, but it is assumed that carefully filtering out non-US stocks from the triggering signal may restore the signal to its original functionality.

The Hindenburg Omen indicator was devised during the longest peacetime economic growth in US history (1955-2007). It is totally unknown how it will cope with multi-year or quarter century economic depression conditions.

Central bank intervention in the stock market can interfere with the triggering mechanism of the Omen. It must be noted that the triggering conditions—with respect to central bank intervention—are quite difficult to manipulate. Most of the Omen's indicators are long term and of a broad market nature. Central banks intervening in the market to keep the Hindenburg Omen from triggering is unknown as there are related market triggers to indicate a downturn is coming—and this one is probably the hardest and costliest to rig.

Results

Looking back at historical data, the probability of a move greater than 5% to the downside after a confirmed Hindenburg Omen was 77%, and usually takes place within the next forty-days.

The probability of a panic sellout was 41% and the probability of a major stock market crash was 24%.

However, the occurrence of a confirmed Hindenburg Omen does not necessarily mean that the stock market will go down, although every NYSE crash since 1985 has been preceded by a Hindenburg Omen.

It can be that the Hindenburg Omen was created to fit the data supplied. If a large data set is used and an analyst tries enough variables, eventually correlations can be found that may not have any predictive significance.

Yet out of the previous 25 confirmed signals only 8% (two) have failed to predict at least mild (2.0% to 4.9%) declines, so it is at best an imperfect technical indicator that is a work in progress.

Latest Omens and Near Misses

August 12, 2010: A Hindenburg Omen occurred, the first since the market lows of 2009. One nearly occurred on August 11, failing only in that 67 stocks hit new lows, rather than the required 69.

June 22, 2007: There were 3,422 NYSE issues traded, with 88 New Highs and 73 New Lows, the lesser number equal to 2.13 percent of total issues traded, almost 2.20 percent. The McClellan Oscillator was negative -116.59.

June 21, 2007: There were 3,434 NYSE issues traded, with 106 New Highs and 75 New Lows, the lesser number equal to 2.18 percent of total issues traded, almost 2.20 percent. The McClellan Oscillator was negative -36.65.

June 13, 2007: There were 3,428 NYSE issues traded, with 96 New Highs and 95 New Lows, the common number equal to 2.77 percent of total issues traded, above the minimum requirement of 2.20 percent. The McClellan Oscillator was negative -116.92.

Additional Resources:

Business Week

http://www.businessweek.com/news/2010-08-13/-hindenburg-omen-suggests-slump-in-stocks-technical-analysis.html